The U.S.-China Trade War Enters Uncharted Waters

In the five predictions we made for 2019 at the beginning of the year, our first and most important was that the trade war between the United States and China would be successfully resolved by June 30. U.S. President Donald Trump and China’s President Xi Jinping are scheduled to meet at the G20 Summit in Osaka, Japan, on June 28, so our prediction may still turn out to be correct. However, I am not quite as confident as I was earlier this year. My fear is that, while the Chinese negotiators may have underestimated Trump’s resolve to fundamentally change the Sino-U.S. relationship and use tariffs as a means to that end, the U.S. negotiating team may have gone down a wrong path by trying to write intellectual property rights (IPR) protections into Chinese law, underestimating Chinese resistance to interference by foreign powers in the internal workings of its government in the process.

On Sunday, May 5, just before the 11th round of U.S.-China trade talks were set to begin in Washington, President Trump surprised everyone when he tweeted that the United States would raise tariffs on $200 billion of Chinese goods from 10 percent to 25 percent on May 10 if he did not see satisfactory progress in the talks. Without actually being part of the negotiations, it is difficult to say precisely what caused the sudden reversal in the discussions between the two countries. Whatever triggered his tweet, however, President Trump was clearly frustrated by the slow progress of the negotiations.

On September 24, 2018, the United States imposed 10 percent tariffs on $200 billion of goods imported from China, with a scheduled increase to 25 percent on January 1, 2019. One result of the very positive dinner that President Trump and President Xi had in Buenos Aires on December 1, 2018, was the postponement of the increase until March 1, 2019. After a number of rounds of seemingly productive negotiations in the months that followed, President Trump once again postponed the imposition of higher tariffs when he reported that the United States and China had made “substantial progress” on important structural issues, including intellectual property protection, technology transfer, agriculture, services, and currency. Assuming that both sides made additional progress, a summit at Mar-a-Lago was being planned to conclude an agreement.

Although the trade negotiators continued their talks in both Beijing and Washington, the Mar-a-Lago summit never happened. Then, on May 10, trade talks took their recent turn for the worse when Trump made good on his threat to raise tariffs, and China retaliated with increased tariffs on $60 billion of goods from the United States. Many explanations have been given for the breakdown in negotiations, but at the core, it would appear that both the Chinese and the U.S. negotiating teams seriously misjudged their counterparts.

Reports say that talks stalled after China tried to delete commitments from a draft agreement that its laws would be changed to enact new policies on issues ranging from intellectual property protection to forced technology transfers. Reportedly, the Chinese negotiators sent the United States a substantially rewritten draft agreement, which led President Trump to accuse Beijing of reneging on settled terms and to threaten higher tariffs. If that is indeed what happened, it will not be the first time that the terms of a deal have been changed at the last minute in China. In fact, a common complaint of foreign executives trying to do business in the country is that negotiations never seem to end. Just when you think you have a deal, it changes.

The difference in this case, though, is that, unlike a company that wants access to the China market and has relatively little leverage, the United States is China’s largest market, and Chinese exporters sell over $500 billion to U.S. customers every year. At the same time, U.S. exports to China are substantially less at about $120 billion. The existence of such a large trade imbalance provides the United States with a great deal of leverage that President Trump has shown he is willing to use. China’s negotiators have obviously underestimated President Trump’s resolve to fundamentally change the direction of the Sino-U.S. relationship and his willingness to impose tariffs on all of China’s exports to the United States, if necessary, to achieve this goal.

However, the U.S. negotiators chose a very legalistic approach to addressing the IPR issue, an approach that seldom works in China. As anyone with experience operating in the country will attest, there are plenty of laws on the books in the country, the problem is enforcement.

At the same time, the U.S. negotiators underestimated the political sensitivity to foreign involvement in Chinese government affairs, striking a deep nerve in the country. A New York Times article in March presciently explained how China’s “century of humiliation” that began with the “unequal treaties” of the 19th century after the first Opium War is “haunting” today’s trade talks between the two countries. While the reform-minded Chinese trade negotiators may have agreed to include IPR provisions in its laws in earlier rounds, the importance that China places on protecting its sovereignty obviously caused others in the country to take a different view.

For example, Chinese State Councilor and Foreign Minister Wang Yi commented that “China will always safeguard its sovereignty, [the] Chinese people’s interests, and national dignity when negotiating with any country.” An editorial in China Daily summarized why sovereignty concerns are so deep-seated in the country:

“…the US seems to take it for granted that tariffs are a weapon it can employ to bring China to its knees and extract one-sided concessions, apparently ignorant to the fact that China is not what it was in the late 1800s and early 1900s when the country was forced into signing humiliating treaties, which resulted in the opening of trading ports and paying of indemnities to Western powers.

Feng Xiaoqing, an intellectual property law professor at the Civil, Commercial and Economic Law School in China is less combative and agrees that China needs to strengthen IPR protections for its own development. Nonetheless, Professor Feng also maintains that “China has to decide the rhythm of its legislation process.”

Enforcing whatever the two countries agree to with respect to IPR protections was always going to be the most difficult part of the trade negotiations. There are no easy ways to accomplish this goal without substantially changing behavior, but the United States seems to have chosen a path that is unlikely to work. Besides not being effective, the reason I am not as optimistic as I once was that the trade war will be successfully resolved in the short term is that the U.S. approach has also struck at a bedrock issue in China. Meanwhile, President Trump’s determination to restore balance and fairness in the relationship between China and the United States is a bedrock issue with him. As a result, he is willing to take steps in dealing with China that no country or U.S. president has ever contemplated.

In this sense, the negotiators on both sides are truly between a rock and a hard place. It is going to take a very creative compromise to bring the talks to a successful resolution, and the world may have to wait some time for such an agreement to appear.

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